RBI in its latest monetary policy had held that banks will not hold more than 10% of their net worth in liquid funds. It held that this move is necessary to prevent the circular flow of money between mutual funds and banks. The banks have been given a time-frame of six-months to toe line with the RBI's directive.
Based on a rough calculation as per the RBI data, Indian scheduled banks put together are worth nearly Rs 5 lakh crore. As of April-end, Rs 1.18 lakh crore of the bank's worth is held in liquid funds.
With the new rule of 10% of net worth being in liquid funds means that of Rs 5 lakh crore only Rs 50,000 crore can be invested in liquid funds. This suggests that there is an excess investment of Rs 68,000 crore in liquid funds.
Liquid funds have assets worth Rs 2.2 lakh crore as per the latest data made available by the mutual funds' body. Therefore, excess investment under the light of total assets suggests that one-third of the total assets will need to be reduced.
According to sources in the mutual fund industry, implementing the rule as stated by the RBI will effect the debt fund category, since banks were the major source of easy money to liquid funds. It is estimated that approximately 80 percent of all the banks in India park their surplus money with liquid funds. Since banks will not be able to invest their surplus money in liquid funds, they will be forced to look for other avenues.
However, the mutual fund houses have stated that there will be no problem in meeting these redemption requests. This category has traditionally seen both huge amounts of inflows and outflows. These funds have routinely seen both inflows and redemptions in excess of Rs 5,00,000 crore every month.
The RBI cited the reason of “circular flow of funds between banks and debt mutual funds" and the “systemic risk" will be harmful for the industry and the economy. This led the central government decision to cap liquid fund investment by banks. While the banks will be parking their money in liquid funds; the liquid funds were in turn placing this money in certificates of deposit, which were issued by banks. Therefore, the RBI feared that this will in effect lead to liquidity risk for banks during a crunch situation.